Federal projects are a big deal for small contractors. But the risks can be big, too.

Just about every contractor likes the idea of federal contracts. There’s a steady stream of new projects, and the invoices almost always get paid on time.

For small or historically disadvantaged businesses, federal contracts are often out of reach—in part because smaller contractors don’t always qualify for the performance or payment bonds required to procure federal contracts.

That’s why set-aside projects are such a vital aspect of federal contracting. It’s a boon for small business concerns (SBCs), and it’s an investment in economic growth for the government. There’s an upside for sureties too, of course—but not without risk. Read on to learn more about the top five set-aside risks, and steps SBCs could take to avoid running afoul of these common risks.

1. Default termination

An SBC, by definition, has only so many resources. By taking on a federal contract, a smaller contractor’s capabilities could be spread too thinly. Work may fall behind schedule, or the company might fail altogether. This can lead to termination of the SBC by either the government or the prime contractor. If that happens, the surety has to step in to protect the federal funds involved and help move the contract to completion.

It’s one of the least desirable outcomes for a project, but it’s one of the most common risks facing set-aside contractors. One way smaller contractors could avoid this unhappy ending is to be straightforward and certain that the scope of a new project is within their capabilities and resources.

2. Limited resources for indemnity

Small businesses usually have limited means, so an SBC is often less prepared to repay their surety provider if a loss happens. Reimbursement terms are usually spelled out in a General Agreement of Indemnity (GAI)—but if a small contractor can’t produce those resources upfront, are they out of luck? Not necessarily.

Several special federal programs exist to help SBCs and sureties work together. One example is the Small Business Administration’s Surety Bond Guarantee Program, which helps repay a surety in case of a loss. It’s a powerful tool for small contractors hoping to qualify for federal projects, and an important confidence-builder for the sureties working with them.

3. Potential for False Claims Act (FCA) lawsuits

While the FCA is a powerful piece of legislation aimed at reducing fraud and waste, it can also be a minefield for the entities involved in a federal project. If a suit is filed under the FCA, everyone from the fraudulent party to the suppliers, subcontractors, prime contractor, and surety could become entangled—and there could be serious financial penalties involved.

An example of an FCA-related problem between sureties and set-aside contractors is if the contractor doesn’t meet the criteria necessary to qualify for federal set-aside work. Some of the most common criteria for qualifying SBCs include:

  • Women-Owned Small Businesses (WOSB)
  • Minority Business Enterprises (MBE)
  • Veteran-Owned Small Businesses (VOSB)
  • Or companies in Historically Underutilized Business Zones (HUBZone)

There are exacting definitions for each of these designations, and small contractors must apply for and prove they fit into a specific category.

For a smaller contractor, a key to avoiding fraud-related issues is to be diligent about how you set up your business, and honest about how you represent it.

4. Improper affiliation finding

This is a close relative of the issue above. If a set-aside contractor obtains eligible small business status but was only able to do so because of its affiliation with another company that had additional resources and managerial control, the set-aside contractor may not meet the necessary qualifications as an SBC.

These complex affiliation determinations depend on intensive analysis of all the facts and circumstances. But if you obtain status as an eligible set-aside contractor and are found to be affiliated with an ineligible company, it could result in termination, suspension, debarment, and criminal or civil penalties.

Once again, a way for a smaller contractor to avoid these problems is to be diligent, truthful and transparent in all business dealings. And because the affiliation question is so complicated, working with experienced legal professionals who can help sort it all out correctly is a must.

5. Too much time, too little profit

Vetting a set-aside contractor to make sure they’re a good fit means expending a lot of time and resources. If the vetting process starts to look more costly than the benefit of doing business together, a surety may need to pass. This is a disappointment for everyone involved.

One way for SBCs to avoid this disappointment is to prepare as carefully as possible. Make sure you’re ready to take on work as a set-aside contractor. Does your company meet the government-mandated criteria for SBCs? Do you have the resources and skills to complete a project on time and on budget? And are you diligent and transparent about your business structure and any affiliations?  Have you worked with an experienced legal professional to ensure compliance with SBA regulations?

If you’ve given a confident yes to all these questions, the next step is to work with a surety bond provider with the strength and resources to be not just your surety, but a trusted advisor.

Liberty Mutual Surety

This document is general in nature and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. Insurance and surety are underwritten by Liberty Mutual Insurance Company or its affiliates or subsidiaries.